Risk budgeting
Allocating an organisation's total risk tolerance across activities, so each has a limit before exposure is taken. Best measured by contribution to total risk, which counts how positions interact.
Where you will meet it
Risk budgeting appears in 6 learning outcomes on the CFA syllabus. A few of them:
- Explain what risk tolerance and risk budgeting mean
“Risk budgeting allocates that total to specific activities, so a limit exists before an exposure is taken rather than after it is questioned.”
- Explain the limits used to control market risk, among them stop-loss limits, scenario limits, position limits, and risk budgeting
“Risk budgeting sets a total amount of risk, measured by VaR, tracking error or another metric, and allocates it among desks, asset classes or managers, ideally where expected return per unit of risk is highest.”
- Explain how risk budgeting is used when building a portfolio
“Risk budgeting sets how much risk the portfolio may take in total, usually as a target active risk, and allocates it across sources so that each source's share of risk matches the reward expected from it.”
- Explain risk budgets set in absolute and in relative terms, and how they guide choosing and carrying out an asset allocation
“A risk budget sets the total risk the investor will accept and allocates it across sources.”
See also
Practise it
Practise risk budgeting until it is automatic: questions that explain every wrong option.
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